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Answer: Assume that a group of market variables change as they did during one of the days in a historical reference period, and apply these changes to the current values of these variables, which are then used to calculate asset values.
A is correct. Historical simulation involves identifying market variables (usually termed risk factors) on which the value of the portfolio under consideration depends. Daily data is collected on the behavior of the risk factors over a period in the past. Scenarios are then created by assuming that the change in each risk factor over the next day corresponds to a change observed during one of the days used in the historical simulation.
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A risk analyst working for a pension fund is tasked with calculating the 1-day Expected Shortfall (ES) for a portfolio using the historical simulation method. To do this, the analyst generates 250 different scenarios for the portfolio. Given the context of historical simulation, which of the following assumptions or methods best describes the most effective way for the analyst to estimate asset values for each scenario?
A
Assume that a group of market variables change as they did during one of the days in a historical reference period, and apply these changes to the current values of these variables, which are then used to calculate asset values.
B
Assume that the values of the assets in the portfolio experience the same percentage change as they did during one of the days in a historical reference period.
C
Assume that a group of market variables has a multivariate normal distribution based on their movements during a historical reference period, and use a sampled value from this distribution to calculate asset values.
D
Assume that the values of the assets in the portfolio have a multivariate normal distribution based on their movements during a historical reference period, and then sample once from this distribution of asset values.